Over at this website, an interesting discussion about fiat money, gold, fractional reserve banking, lending and borrowing, what a new monetary system might look like.

The thesis appears to be that fiat money is politically inevitable, whatever its infirmities, and that a monetary system based on fiat will always surface and eventually implode. This is a fallen world, so to speak.

Yet rather than the usual dichotomy, the “either-or” of a gold standard money versus irredeemable fiat money, FOFOA (an acronym for, I believe, Friend of a Friend of Another, “Another” being a relatively ancient pseudonymous internet personality) seems to advocate a hybrid, with fiat money freely circulating and being borrowed and loaned just as it has been; and an unregulated, presumably unofficial and I guess underground world of real money, which would be physical gold as the one and only final payment medium, and which could not be loaned or borrowed.

Thus the moniker “Freegold”.

I admit to an odd attraction to this idea, and FOFOA’s discussions and posts seem to have a lot of depth, touching not only on economics issues but also psychology, politics, anthropology, philosophy, history and even a little religion. He also seems to appreciate the fact that law has a big role to play in monetary matters, unusual among bloggers of this kind.

However, the most pertinent idea for my purposes, thus far, is his idea that the lending and borrowing of physical gold should be prohibited.

One of the problems of the Austrian economists and other gold bugs is the somewhat useless fixation with abolishing fractional reserve lending. For the most part, I agree that fractional reserve lending is a bad thing. That’s not the problem I have with the proposal to abolish it. The problem I have with it is, how would you do that? I have asked and asked without receiving anything even approaching a satisfactory answer.

Making the practice a crime would be worse than prohibition: let’s not forget that when lending was largely unavailable, organized crime filled the gap and we saw rather brutal loan sharking. It would seem that Austrian economists, who are self-described libertarians, would see this problem and have an answer for it. Some answer that we don’t need to criminalize fractional reserve lending, that the “market” would solve the problem because savvy savers would figure out which banks had committed “fraud” and loaned out their money. But are they saying that this fraud should be prosecuted criminally by the government? That’s just a different way of criminalizing the practice itself. Or are they saying that the defrauded depositors would have some other recourse? What would that be? They can’t get their money back – it’s been loaned out. What do they do? Some kind of violence? These guys never say.

I think it’s because there isn’t a solution to the problem. It’s in the nature of people to borrow and lend, and that leads to banks, and that leads to fractional reserve lending. You might as well try to do away with alcohol. Oh wait, we did that. It didn’t work.

FOFOA has a good sense of this. He seems to recognize that fractional reserve lending is going to occur. And if I understand him correctly, he believes that it could be restricted to fiat money alone, and that you could have a monetary system where gold was not loaned or borrowed. He even understands that this is more of a legal system than a monetary system.

There are some things that the law can do effectively, and some things it can’t. Legal tender laws work. That’s not to say they’re a good thing, just that they work pretty much the way they’re intended to. The law can also effectively define the monetary unit of account – the dollar, for example – in gold terms.

The law could not effectively prohibit borrowing and lending money, even in the passive sense of not enforcing such contracts in the courts, because many people will do it anyway, and the enforcement of the contracts will become ugly and violent. But could the law recognize one kind of money – fiat – that you could borrow and lend; and another kind – physical gold – concerning which courts would not enforce lending and borrowing contracts, and avoid the problems of loan sharking, since lawful institutions could still loan fiat “money” but not gold?

I really don’t know whether such a bifurcated system would be advantageous or not. It just interests me. I think there’s something to it. I think the law could effectively eliminate gold lending if there were another kind of money that could be lent. And that would have the effect of establishing a savings medium which would not be subject to the ravages of fractional reserve dilution, which could conceivably be largely confined to the other kind of money – fiat.

But the effects of all this are very difficult to gauge. “Freegold”? I don’t know. I’m thinking about it.

Like this:

Related

2 responses to ““Freegold”?”

I decided to take up your invitation to visit your blog and read both(?) of the posts I found here presenting your perspective and response to the Freegold concept as you interpret it.

I was intrigued to learn that you had not been able to obtain answers from Austrian school economists to fairly straightforward questions such as this one:For the most part, I agree that fractional reserve lending is a bad thing. That’s not the problem I have with the proposal to abolish it. The problem I have with it is, how would you do that?

I have been studying the work of various economic thinkers for several years. In regard to the above question (and other issues you raise) I would recommend a book by Professor Jesus Huerta De Soto called “Money, Bank Credit and Economic Cycles”. (My copy came from the Mises Institute.)

It should appeal to you on several levels. Professor De Soto begins his text with an exploration of the legal nature of loan and irregular deposit contracts. He approaches the discussion with a perspective informed by Roman classical law. To give you some sense of De Soto’s depth of scholarship, the bibliography runs to 44 pages.

Professor De Soto would be a far better source to look to for a response to your question but I will make an attempt to answer it.

Part of the Austrians strategy to prevent fractional reserve lending involves making it illegal for banks to lend demand deposits. These deposits would be held in safe custody in the same way other custodial services for fungible goods are operated. By inference, no interest would be payable. In all likelihood there would be a fee levied for these “storage” services by the bank.

Currency placed with a bank for on-lending at interest would be expressly acknowledged as a loan to the bank. Thus the funds available to lend are equal to the funds lent to the bank. If, say, the funds lent by a bank are deposited with another bank, as a demand deposit, it would not enable that bank to onlend the funds. The banks’ interest margin would make it unlikely that a bank loan would be reloaned to another bank.

Other schools of economics argue that our present banking system functions quite differently to the way the Austrians perceive it. I’m not seeking to adjudicate, merely to give you my understanding of part of the Austrian schools strategy.

He’s very scholarly, which is fine, except when you get down to the nitty gritty of passing a law pretty much every scholar is too removed from the real world.

Making fractional reserve lending of demand deposits or anything else “illegal” would be prohibition revisited, and decidedly un-libertarian. The most the law can realistically do is refuse to enforce those lending contracts. This can be very effective in reducing a practice like that, but the flip side is that black market lending becomes common, with many attendant social ills.

I’m mulling over the idea that this is preferable to either alternative – making fractional reserve lending criminal or something like that on the one hand; or explicitly allowing it but “regulating” it, which is the abominable situation we have now. Perhaps we have to accept that a few people will experience unfortunate and disproportionate suffering from their decision to borrow from a loan shark, and this is part of the cost of maintaining the law for everyone else. Dunno right now.